Natural DisastersNatural Disastersand Tax Deductible Reservesand Tax Deductible Reserves

Natural DisastersNatural Disastersand Tax Deductible Reservesand Tax Deductible Reserves

Kevin McCartyKevin McCarty

Florida Department of InsuranceFlorida Department of Insurance

CAS Ratemaking SeminarCAS Ratemaking Seminar

March 11 & 12, 1999March 11 & 12, 1999

1/500 Year Insured Losses 1/500 Year Insured Losses Estimated by Risk Management Solutions, ISOEstimated by Risk Management Solutions, ISO

1/500 Year Insured Losses 1/500 Year Insured Losses Estimated by Risk Management Solutions, ISOEstimated by Risk Management Solutions, ISO

Sources: U.S. Geological Survey, Uniform Building Codes, Council of State Governments

$66 BillionEarthquake

San Francisco

$71 BillionEarthquakeLos Angeles

$101 BillionEarthquake

New Madrid Region

$22 BillionHurricane

Houston-Galveston

$21 BillionHurricane

Northeast Region

$17 BillionHurricane

Southeast Region

$76 BillionHurricane

Florida Region

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Current Tax, Accounting RulesCurrent Tax, Accounting RulesCurrent Tax, Accounting RulesCurrent Tax, Accounting Rules

RulesRules

GAAP and Insurance Statutory Accounting Reserves for future catastrophes not allowed

Internal Revenue Code: Event must have occurred to be deductible

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Drawbacks to Current Drawbacks to Current Tax and AccountingTax and Accounting

Drawbacks to Current Drawbacks to Current Tax and AccountingTax and Accounting

Do Not Allow Insurers To Establish Reserves for Future Catastrophes

Current Tax Law:Transfers Policyholder Risk Capital to Government Increases Cost of InsuranceCan Reduce Availability, Especially in Rate Constrained States Current Accounting Rules: Transfer Cat Premiums to Surplus Prematurely Mask Need for Capital Retention

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How Other Major Industrial How Other Major Industrial Countries Deal With The IssueCountries Deal With The IssueHow Other Major Industrial How Other Major Industrial Countries Deal With The IssueCountries Deal With The Issue

Most major industrialized countries allow or require insurers to establish reserves for future catastrophic exposures.

Each country has its own rules for setting up and drawing down such reserves, but all have reserves that are tax deductible.

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NAIC Tax-Deductible Cat Reserve NAIC Tax-Deductible Cat Reserve Key Characteristics Key Characteristics

NAIC Tax-Deductible Cat Reserve NAIC Tax-Deductible Cat Reserve Key Characteristics Key Characteristics

Reserve Requirements

Tax-Deductible

Statutory Liability

Cover Mega-Cats

Mandatory

Tax Deductibility a Precondition Required Statutory Liability Cover U.S. Exposures Apply to Catastrophe-Prone Lines Offset Qualified Losses from

Specified “Named” Perils Focus on High Impact Events

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Purposes of Tax-Deductible Purposes of Tax-Deductible Catastrophe ReserveCatastrophe Reserve

Purposes of Tax-Deductible Purposes of Tax-Deductible Catastrophe ReserveCatastrophe Reserve

Retain Cat Premiums to Cover Long-Term Exposures Better Provision Insurers to Deal With Mega-Cats Assure Consumers, Regulators That Cat Portion

of Rates will be Available for Intended Purpose

Prevent Premature Allocation of Policyholder Risk Capital:To Federal Government Through TaxesTo Surplus for Distribution to Owners or to Cover Other Risks

Augment (Not Displace) Other Funding Sources

NAIC Tax-Deductible Cat Reserve NAIC Tax-Deductible Cat Reserve Covered Lines & Perils Covered Lines & Perils

NAIC Tax-Deductible Cat Reserve NAIC Tax-Deductible Cat Reserve Covered Lines & Perils Covered Lines & Perils

_____ Perils______

Wind Earthquake/Fire Following Tsunami Fire Flood Hail Snow, Ice, Freezing Volcanic Eruption

____Covered Lines_____

Fire Allied Lines Earthquake Homeowners M/P Farmowners M/P Commercial M/P Private Passenger Auto P/D Commercial Auto P/D

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NAIC Tax-Deductible Cat Reserve NAIC Tax-Deductible Cat Reserve Eligible Insurers Eligible Insurers

NAIC Tax-Deductible Cat Reserve NAIC Tax-Deductible Cat Reserve Eligible Insurers Eligible Insurers

Any Entity Required to File a NAIC Property Casualty Annual Statement Blank

Exceptions: Insurers Taxed on Investment Income

(Premium less than $1.2 M) Insurers Not Subject to Federal Taxation

(Premium less than $350K) Unless Commissioner Requires

NAIC Cat Reserve Annual AdditionsNAIC Cat Reserve Annual Additions NAIC Cat Reserve Annual AdditionsNAIC Cat Reserve Annual Additions

Grow Industry Reserve Gradually $2B Per Year Based on 1996 Premium Levels

By-State, By-Line Cat

Exposure Factors

XX

Insurer Direct Plus Assumed

Less Ceded Premium

( )XX

Ratio of Premiums

Less Ceded Excess to Premiums

==Insurer Annual Reserve Addition

Subject to: Cap (20 X Current Year’s Accumulation) Rolloff, if Not Used After 40 Years

Allocate to Insurers Based on Relative Catastrophe Exposure and Premiums

NAIC Cat Reserve Exposure NAIC Cat Reserve Exposure FactorsFactors

Based on Insured Losses from 1967-1996 for Covered Lines Which Exceeded PCS Cat Losses

AL

AK

AR

AZ

Etc.

Fire Allied Etc.

…

...

PPAuto

.0093

.0044

.0056 ....0122 .0114

... ...... ...

.0179

.0145

.0163

.1761

.0099

.0693 ....0020

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Losses Loss Adjustment Expenses Assessments, surcharges and other liabilities

attributable to a qualifying catastrophe Net of reinsurance, subrogation/salvage

NAIC Cat Reserve NAIC Cat Reserve Qualifying Losses Qualifying Losses

NAIC Cat Reserve NAIC Cat Reserve Qualifying Losses Qualifying Losses

NAIC Cat Reserve Drawdown CriteriaNAIC Cat Reserve Drawdown CriteriaNAIC Cat Reserve Drawdown CriteriaNAIC Cat Reserve Drawdown CriteriaCatastrophe Declared by PCS

Results From Named Peril>$10B >$10B

Industry Cat; Industry Cat; Insurer’s Insurer’s Losses Losses

Exceed 20% Exceed 20% Insurer CapInsurer Cap

Insurer’s Insurer’s Annual Cat Annual Cat

Losses Losses Exceed 40% Exceed 40% Insurer CapInsurer Cap

or

Insurer’s Insurer’s Annual Cat Annual Cat

Losses Losses Exceed 15% Exceed 15%

Insurer Insurer SurplusSurplus

or

Release Reserve to Extent of Net Excess LossesRelease Reserve to Extent of Net Excess Losses

Yes

Release Also Required If:Release Also Required If:

YesReserve Exceeds

Insurer Cap YesRegulator Requires to Forestall Insolvency

Addition Addition Not Used Not Used

After 40 Yrs.After 40 Yrs.

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Benefits: More Explicit Recognition of Cat Exposures More Accountability (Less “Transparency” of Risk) More Dedicated Capital to Cover Cat Risks (Pre-Event) More Industry Stability, Fewer Insolvencies/Assessments More U.S. Based Reinsurance More Availability of Catastrophe Insurance Less State, Federal Disaster Assistance for Insurable Losses More Local Economic Stability, Growth

Costs: Less Tax Revenue From Insurers

NAIC Cat ReservesNAIC Cat ReservesBenefits and CostsBenefits and Costs

NAIC Cat ReservesNAIC Cat ReservesBenefits and CostsBenefits and Costs

1515

Considerations in Considerations in EvaluationEvaluation

Considerations in Considerations in EvaluationEvaluation

Federal Budget Scoring “Dynamic” Benefits:

Insurers’ Risk Bearing Capacity/Desire Insurance Industry Solvency after Mega-Catastrophe Availability, Affordability of Catastrophe Insurance Consumer Insurance Choices Reinsurance, Capital Markets Local, State, National Economies Federal, State Disaster Assistance

NAIC Survey, Analysis

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Tax-Deductible Cat Reserves Tax-Deductible Cat Reserves Tough QuestionsTough Questions

Tax-Deductible Cat Reserves Tax-Deductible Cat Reserves Tough QuestionsTough Questions

Is Tax Deduction Achievable/Advisable? Public Policy Imperatives vs. Budget Impact

Will NAIC Keep Tax Deduction as Precondition for Accounting Change?

Will It Improve Industry Solvency? Catastrophe Insurance Markets?

How Will It Be Coordinated With State, Federal-based Initiatives? Reinsurance, Capital Markets? Other Initiatives?

1717

Tax-Deductible Cat Reserves Tax-Deductible Cat Reserves NAIC Development TimelineNAIC Development TimelineTax-Deductible Cat Reserves Tax-Deductible Cat Reserves NAIC Development TimelineNAIC Development Timeline

Evaluate and Comment March ‘99

Make Appropriate Revisions July ‘99

Conditional NAIC Adoption Fall ‘99

Federal Tax Consideration 1999

Final NAIC Adoption After Tax Deduction